Thread by @RonStoeferle

It seems that #Zoltan has been quite busy lately!

The newest, already 5th part of his "War"-series, was published on January 6th.

In this little #thread i've summarized some of the highlights of his piece "War and Peace:

🧵

"... four “war” dispatches last year: War and Interest Rates, War and Industrial Policy, War and Commodity Encumbrance, and finally, War and Currency Statecraft. In these, I identified six fronts (..) in “macro-land” () where Great Powers were going “at it” in 2022:

"the G7’s financial blockade of Russia, Russia’s energy blockade of the EU, the U.S.’s technology blockade of China, China’s naval blockade of Taiwan, the U.S.’s “blockade” of the EU’s EV sector with the Inflation Reduction Act,

and China’s “pincer movement” around all of OPEC+ with the growing trend of invoicing oil and gas sales in renminbi. Those were six geopolitical events in one single year, that is, a geopolitical curveball to deal with every two months."

"I don’t think 2023 will be different: in a number of regions in Europe and Asia, the threat of a hot war is real; the BRICS are set to expand with new members (“BRICSpansion”), which means more de-dollarization of EM trade flows; CBDCs are spreading like kudzu,

with Türkiye the latest country to launch one; and with the launch of every new CBDC, the potential of Project mBridge to diminish the role of the dollar in FX transactions and trade invoicing will rise..."

"Monetary and fiscal responses were just that – responses to mother nature and geopolitics – and with geopolitics getting more complicated, not less, investors should remain mindful of the threat of non-linear risks in 2023."

"..investors are not particularly well trained to deal with geopolitical risk, because for generations geopolitics didn’t matter – anyone who traded securities or ran a portfolio since the end of World War II, did so in the cocoon of a unipolar world order.."

"When Henry Kissinger writes about how to avoid another world war (henryakissinger.com/articles/the-p…), and
Niall Ferguson writes about the risk of Cold War II spilling into World War III in an op-ed on Bloomberg (bloomberg.com/opinion/articl…), you know that something is definitely up…"

"Pre-WWII parallels are once again relevant, with a new reading list: Mackinder’s The Geopolitical Pivot of History (amazon.com/Geographical-P…), Brzezinski’s The Grand Chessboard, and
Herman’s Freedom’s Forge."

"In my “war” dispatches, I stressed four themes:

1. War is inflationary.
2. War means industry.
3. War encumbers commodities.
4. War cuts new financial channels.

In today’s dispatch, I will add a fifth theme:

5. War upsets all four prices of money."

"As many have learned from Perry Mehrling, money has four prices (par, interest, foreign exchange, and the price level), and as Niall Ferguson noted in his essay, “we forgot that war is history’s favorite driver of inflation”.

"In my field, “polycrisis” means that all four prices of money are having a crisis:

the collapse of stable coins is a crisis of par; an unprecedented pace of hikes with a (still) uncertain level for the terminal rate is a crisis of policy rates (OIS); the volatility in the price

of crypto, DM, and EM currencies are crises of FX;
and, as discussed above, all these crises are due to a crisis of the price level – that is a crisis of inflation – which, in turn, has been driven by mother nature
and geopolitics."

"In the domain of the second price (interest rates), spreads around OIS have been fairly quiet to date: only credit spreads had blowouts, but
not swap spreads.

But with Treasuries, I see a conceptual problem brewing…"

"..the Fed would have to restart QE
sometime during the summer of 2023, and according to page 6 of this report (bridgewater.com/_document/an-u…),“the amount of government debt that will need to be absorbed by the private sector in [2023] is larger than at any time outside of world wars”.

"So if the “classic” marginal buyers won’t buy, who will?

...my sense is that this is a “checkmate-like” situation: the Fed won’t be a pivot and the terminal rate may have to go higher still, neither of which augurs well for either risk assets (sell-off, then into Treasuries)..

or Treasuries (rates sell-off, then risk sell-off, then into Treasuries). “Hot wars in cold places and cold wars in hot places” need “war finance”, not QT.

There is a solution to the poor demand for Treasuries, which is QE under the “guise” of yield curve control, which my instinct says will come by the end of 2023 to control where U.S. Treasuries trade versus OIS.
The put is dead, long live the put!"

The put under risk assets is dead: Powell didn’t mention stocks at Jackson Hole.

The put under government bonds is about to be born: the “baby” conceived already in a CGFS report, titled, Market Dysfunction and Central Bank Tools (bis.org/publ/mc_insigh…).

The report says that if government bond markets become dysfunctional, central banks should provide a backstop.
"..don’t expect the put under government debt to prop up risk assets: unlike QE in the context of low interest rates and a risk asset put,..

the coming QE will be in the context of Treasury market disfunction."..

"next round of QE will aim to “keep the wheels on the cart” amid high inflation, growing geopolitical tension,
and an ugly financial divorce between the West and the global East and South."

In closing the fifth and final “chapter” of my “war” series, consider this quote from Tolstoy:

“The most difficult subjects can be explained to the most slowwitted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most...

..intelligent man if he is firmly persuaded
that he knows already – without a shadow of doubt – what is laid before him.”

What does all this mean for one’s portfolio and the price of various instruments:

1. 60/40 won’t cut it anymore and should be 20/40/20/20 instead, with the weights representing cash, stocks, bonds, and commodities.

2. Cash, while the curve remains inverted, is “king”. It provides a nice yield, has no duration risk, and, as Warren Buffet said, it has an option value.

3. Commodities should include three types of gold: yellow, black, and white.

Yellow gold is gold bars. Black gold is oil. White gold is lithium for EVs.

4. Commodities should also include a range of other stuff like copper, cobalt, et cetera, and the general theme driving commodities is that…

5. …after years of underinvestment, supply became extraordinarily tight, just as we re-arm, re-shore, re-stock, and re-wire the grid.
6. The U.S. dollar won’t be de-throned overnight…

7. …but on the margin, de-dollarization and digitization (CBDCs) by BRICS+ central banks will reduce dollar dominance and demand for Treasuries.

8. The dollar’s or weakness should be thought of in the context of the four prices of money (that is, par, interest, FX, and the price level):

9. The U.S. dollar will remain “FX” strong versus other DM currencies…

10. …but will be become “price level” weak (that is, outright devalue) versus commodities and “FX” weak versus most BRICs currencies…

…which will guarantee plenty of volatility in all four prices of money this decade.
Good luck in 2023 and beyond…"

THE END of the #THREAD

#ThanksZoltan, great work as always!!!

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